Mon, 24 May 2004

Trade Deficits

People are, like, massively confused about "trade deficits", y'know? So often you hear this or that pundit pontificating about how horrible it is that we have a trade deficit with one country or another. We currently have a trade deficit with China.

It's more or less meaningless to compare the volume of goods sold by Chinamen to Americans against the volume of goods sold by Americans to Chinamen. They have very little to do with each other. Often you can make sense of trade issues by bringing them home. If it makes sense in your family, then it makes sense in international trade (if only because countries tend to act like two-year-olds!)

Let's say that you are a student at the University of Illinois at Chicago (UIC). You have a trade deficit with them. You buy more from them than you sell to them. Assuming that you can get the necessary tuition money, does anybody perceive this situation as a problem? The trade deficit could go on forever. Certainly there are some gradual students who would prefer that state of affairs.

Note the assumption, though. To make the previous paragraph true, I had to assume that you had a source of tuition funds. Where are the tuition funds going to come from? Let's say that you are very good at something, and you can do that thing well enough to earn enough money to pay the tuition, whilst still leaving you enough time for college classes. You could stay in college forever and have a permanent trade deficit with UIC.

In case that's not clear enough, consider that you have a permanent trade deficit with the supermarket that you buy your food from. They are forever selling you things, you are forever paying them, and yet you NEVER offer to sell them anything. Nobody has a problem with this. Nobody is decrying the trade deficits that customers everywhere have with stores. Of course not, because the concept is just wrong.

Another way to look at it: your employer has a trade deficit with you. You are constantly providing services for him; he is constantly paying you; and you rarely if ever buy anything that you produce for him.

Do you see why a "trade deficit with China" is a confusing idea? It has, at its core, an assumption that we are ultimately bartering with China -- that the sum total of goods we sell to them must be equal in value to the sum total of goods they sell to us. But we can sell things to Japan, who sells things to China, who sells things to us. That makes for three trade deficits and yet lots of happy people.

A trade deficit with everybody

Some people are less confused than others. They worry, instead, about having a trade deficit with everybody. Let's go back to our example. Let's say that we constantly shopped; had a trade deficit with every store we enter. To keep this relevent to international trade, let's say that we used our personal IOUs to pay (being a proxy for dollars). As long as we redeem our IOUs faithfully, stores will continue to accept them. If they pile up too excessively (trade deficit with the world), people are going to be reluctant to accept our IOUs. In the parlance of international trade, our IOUs (currency) will decrease in value. The dollar will fall against other currencies. Foreign products will be more expensive in dollars than they were. Our exports will be cheaper.

The goal is to import as much as you can, and export as little as you can. "Buy low, sell high" is not new financial advice. People will help us import by giving us some credit (by taking our money/IOUs), but only if we have a history of paying back the credit. In order to do this, we have to create products that other people want to buy. To the extent that we do this well, we won't have to export much (work hard) to get the imported goods we want.

There are other ways to get people to redeem our IOUs/dollars. We could sell ownership in our businesses. That has happened -- a LOT. Several reasons for this: 1) American businesses are very productive. We make very efficient use of capital. 2) Ownership is very secure in America. Businesses don't get expropriated like they do in other countries. 3) The dollar is widely accepted. Because of #1 and #2, Russians will accept dollars from Gambians. 4) The dollar has been fairly stable of late. We haven't been printing up new dollars since Reagan's presidency. That makes the dollar a reasonable currency to hold.

If people are willing to buy businesses in the USA, then just like a supermarket, we can have a trade deficit with the rest of the world forever. We need to stay productive, but it's not the bad thing that some pundits posit. We can keep creating new businesses to sell to foreigners until the cows come home.

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